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10/03/2005
The Economic and Investment Implications of Delay

A key question in decision-making in all areas is how much delay is good. Delay reduces uncertainty and mistakes, but it costs time. The question arises in markets on numerous fronts -- most recently when the S&P rose from 1216 at the close on Sept. 21 to 1223 on Sept. 28 with five small daily gains in a row. That was a historic kind of delayed move that has typically been somewhat short-term bullish, and as it turned out, it continued up to 1234 in the next two days.

Areas in investments where decisions on optimal delay are important are legion. Here are just a few examples. Before an important economic announcement such as the monthly employment numbers, when do we step up to the plate? What about the optimal timing relative to the release of an earnings report or guidance by a company? When do you take a position in a stock after receiving a tip? How many analysts and research reports do you study before pulling the trigger? More generally, how do you weigh events that are likely to occur at different proximities to the present?

Major efforts to come up with frameworks for deciding on the proper amount of delay have come from economics, psychology, statistics, electronics and sports. The economic approach is to note that information is an economic good that has an opportunity cost. To get more information, you have to give up time, money and effort. Proper decision-making involves waiting until the cost of acquiring more information is greater than the anticipated benefits that the information provides.

A related economic framework is the analysis of how consumers decide between current and future consumption. The analysis depends on how impatient they are, what the rate of interest is, the availability of borrowing and the path of expected future income. A simple analysis of this is contained in Price Theory and Applications by Jack and David Hirshleifer. They show that for impatient people, current consumption will be high and savings low, and the rate of interest that they will pay will be high. The reverse is true for patient people. They apply this to historic events by considering how farsighted (patient) and family-oriented a person is. "The later years of the Roman Empire were characterized by a decline in such puritanical attitudes and a shift towards impatience, and interest rates accordingly rose."

In a surprising extension for economists they relate it also to biological factors such as average lifespan and size of families. "In recent times, these considerations have operated in opposite directions. Rising lifespans have encouraged saving while smaller family sizes have discouraged it." A more extensive and wide-ranging consideration of time preferences and their influence on economic behavior is contained in Chapter 16, "Consumer and Supplier Behavior Over Time," in Pashigian's Price Theory and Applications.

The statistical approach to the proper amount of delay, is based on George Stigler's classic article "The Economics of Information," JPE 1961. The information gained from searching is constantly decreasing. For simple models of finding the best price when the distribution of prices is uniform, the searcher gains 87% of the total information after three quotations from purveyors so it makes sense  for most people with reasonable alternate uses for their time to stop searching after three or four such quotations.

The psychological approach to the proper amount of delay is probably the most fruitful for decision-makers. A classic and highly fruitful article in this regard is by George Lowenstein and Ted O' Donoghue, "Animal Spirits: Affective and Deliberative Processes in Economic Behavior." The authors divide decision-making into a balance between two parts of the brain: the deliberative or patient part, and the affective or impatient part. The balance between them is determined by willpower, which they view as "a resource expended by the deliberative system to exert influence over the affective system." Their approach enables them to explain most of the seemingly irrational behavior that behavioral finance has uncovered, such as loss aversion, the vividness effect and the excessive weighting of improbable outcomes like winning a lottery.

The approach to decision-making about the proper amount of delay that most of us have the greatest degree of familiarity with comes from sports. The best players seem to be the most patient. However, among average players, often the impulsive and action-oriented player takes home the prize. I had personal experience with the former approach as the great coach Jack Barnaby would often sit behind me during a game and bellow before I was ready to strike, "Waaait," thereby making my opponent commit himself. Tom Wiswell, undefeated checker champion for 25 years, often emphasized a similar strategy in checkers; he pointed out the importance of first developing a good "base of operations" in your game and then employing good "waiting moves" as a key to victory. On the other hand, Art Bisguier in chess liked to concentrate on the importance of seizing the initiative when the main chance was there. However, I believe that Art would be the first to acknowledge that at the top levels, the more patient players who develop a good foundation are the most likely to win.

As to how to apply these insights to markets, the situation is complicated by the principle that investors get paid for assuming risk. The more they wait, the lower the risk and uncertainty, and therefore the less likely they are to achieve above-average returns. The Collab and I when we wrote Practical Speculation at the bottom of the market in February 2003 were roundly criticized and or ignored because we emphasized the value of buy-and-hold and the likely above-average returns from seizing the initiative from the bears circs S&P 800. Yes, it would have reduced chances of mistake to wait until all the companies and analysts were prohibited from releasing or doing anything unique. But the benefits of additional waiting and searching seemed orders of magnitude lower than the opportunity cost of eschewing the 1.5 million percent-a-century return documented by the Triumphal Trio.

Perhaps the best approach is to prepare a proper foundation well in advance with scientific study of the impact of waiting for various events, and then to take action when the benefits of accepting uncertainty are greater than the future information to be obtained. (This is a work in progress, and I solicit insights of readers from their own fields of expertise and interest.)

GM Nigel Davies adds:

Some chess players can't wait to play a good move if they see one (Heikki Westerinen for example), others like to hold them in reserve. There are also sharp/direct openings vs. those in which there is a longer build-up. The former feature a quick dissipation of energy which often burns out to a draw; the latter often feature prolonged tension and can explode much later.

 

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